Monday, November 3, 2014

House Lust

I want this house.

I owe you all an apology. I've once again fallen off the radar, both from writing on this blog and from reading yours. There are a lot of little reasons. For one, as I work from home, I've moved my laptop to the living room as my computer is a constant distraction during work hours. This is good for my career but, admittedly, not so good for reading or writing blogs from nine to five. As often happens with habit change, there are unintended consequences (i.e. - I don't use my laptop very much in the evenings). I've also been studying for a professional certification, with the first out of three tests now completed. The tests are proving harder than I thought they'd be. But my biggest time bandit has been house lust.
Earlier in the summer, we bought our first single family home as a rental. Then, two months later, we bought a second in the same city. They're both rented now, and cash-flowing well. The transactions went so well, in fact, that we thought, "Hey, why not keep it going?" We've been stacking up cash for years, earning a negative real return, for this very purpose. There's a big part of me that dislikes having this much money held in a cash position, and this is one investment that Mrs. Done by Forty is comfortable holding. Our plan, at least at the moment, is to try to get ten rentals or more by the time we pull the trigger on early retirement.

The rub is that evaluating properties and potential markets is shockingly time consuming. There's a lot of information to obtain and verify for just one city, one turnkey company, or one house, for that matter. The majority of options don't end up looking like good ones when it's all said and done. Like momma told us, you've got to kiss a lot of frogs.

Even when you do find a prince, it's not like you can skip ahead to the wedding. There are negotiations to perform, contracts to redline, renovations to be made and supervised, a small mountain of docs to gather for the lender, inspections to be done and appraisals to get through. At any stage of the process, the deal can fall apart...like one did for us last month. One lender apparently had difficulty funding a flip, but only found this out after we'd paid for an inspection and an appraisal. We moved on to a second lender and paying for a second appraisal...which came back low. Ultimately we decided we'd had enough and walked from the deal. But the money we'd already paid was done and gone. It's a sunk cost....and not the kind that help us.

The whole ordeal has given us pause for thought. We love rental property, but we are neophytes and are learning on the fly. Rentals take a lot more time and expertise to manage than a boring old index fund. Additionally, we're learning that diversification is especially hard with houses.

We have a vision of owning one or two homes in a handful of different cities. We have family in southern California, so that might be an option. But each time we want to invest in a new city, we need to find and vet a new company, try to discern the quality of the neighborhoods, find a new lender, new inspectors...and on and on. Then there are the contractors. We might be able to find a plumber in Los Angeles, but what if the house needs an electrician, roofer, or mason? Do we just pick names out of the phone book? Simply put, there's some risk in 'starting over' with a whole new cast of characters in a new city. Diversification is a good idea, but it comes with its own hurdles.

And then there are the constant warnings about real estate of one of my favorite bloggers, Garth Turner. His blog, Greater Fool, warns Canadians (and paranoid Arizonans) about the folly of putting all your money in one asset basket, excessive debt, and the genuinely terrifying Canadian real estate bubble. His warnings hit home because we're fixing to load up on debt and real estate at the exact moment he's cautioning his readers about doing just that. Now, we're buying cash flow positive rentals instead of lavish personal residences...but on some levels the risks are the same. Properties, like any asset, can decrease in value. Leverage can be good, but often is dangerous. Repairs can be expensive. Homeowners can be sued.

As usual, I have more questions than answers. We really want rental income to be a big part of our early retirement plan, but aren't sure how to prudently move into different cities without "picking a name out the phone book". Do you readers have any ideas? Would you simply load up in the city we're currently invested in, since we have a positive track record with the turnkey company and contractors we've already used? Would you just push forward with new regions and third parties?

43 comments:

Great to see another post from you. Definitely sounds like you've had a lot on your plate lately, but great you're putting your energy where it's most important for you right now - congrats on getting through your first test!

Also great to see you putting so much effort in to your real estate investing, really sounds like you're doing some serious due diligence on these investments and your overall plans. Unfortunately I can't offer too much wisdom here, as the stock market is my investment vehicle of choice (is there such thing as 'stock' lust?), but definitely sounds like you're asking lots of great questions, and focusing on protecting your downside and understanding what could go wrong. I look forward to hearing more about your progress in growing your property portfolio (regardless of whether you post once a month or twice a week!)

I can sympathize with everything you are talking about in this post. Rentals are a great investment but do take a lot of work, contrary to what most people think.

We have chosen to only buy properties that are local and for now we manage them ourselves. By local I mean within our own county. It's tough enough to keep up with things locally let alone branching out into other cities or regions of the country. I can see the benefits in owning property in a cheaper part of the country. I wouldn't want to deal with it though and would have to hire a property management company to oversee it for me. Right now I don't want to spend the money for that service.

I'd suggest watching the debt exposure very carefully. We own our properties free and clear and will not purchase another one until we can do so with cash. I know that takes awhile to build up that much cash but I'd rather remove the risk factor of being in debt from my business.

We definitely use a property management company (8% of rents, plus about $500 when a tenant turns over). But it's a necessity for us.

I love that you guys are going the cash only route. We considered it, especially as we own our own home outright. But ultimately we decided we're okay using leverage for cashflowing assets, so long as it's monitored as you said. Right now, our debt load is pretty reasonable (less than $140k)...but that'll creep up with each loan.

I am in the middle of a remodel, and I know how the outside forces affect the blogging...

RE is great, but you need to diversify. Have a solid stock portfolio too. My goal, which is almost there, is 50/50 RE equity and stocks. Stocks should provide a solid 4% forever, and RE solid income until I sell.

Keep going, it is tough to replace your income by 40, but can be done.

Great advice on the asset allocation. Since we own our home outright, our equity in RE is pretty high. But it also keeps expenses low, so there's the tradeoff. Coincidentally, we're very close to that same 50/50 split.

Good to hear from you, DB40!!! I miss your witty and educational posts. :-) If I were you, I'd keep buying where you're at. You know the area well and have a great track record/great companies to work with. And AZ is always a hot spot, it seems, for people to want to live.

I acquired several rental properties from my mother and the first thing I did was develop a schedule to sell them. I hated being a landlord. My mom pretty much adopted her tenants into a little brood of people who, according to my mom, couldn't live without renting from her. Not a smart way to run a business because some of the people stiffed her on a regular basis. I've now gotten rid of all the rentals and have the money invested in a variety of bonds and dividend paying stocks, and now I sleep at night.

I can definitely see how landlording can be a pain, Kathy. We use a property manager so that takes some of the headache out of it, but certainly not all of it. We still ultimately have to make the decisions, pay the bills, etc...

I may ultimately come to the same conclusion as you, and just go the paper investment route.

Have you considered a multi-unit property near your area or with a company you have already worked with? This would prevent having homes in 10 different cities and still give you the number of units/rentals you are looking to obtain, this would alleviate some of the stress of vetting multiple companies, loans, etc.

I seriously considered trying to get a rental property in Las Vegas because, hey, discounted trips based on effective tax rates FTW! However, while you would not learn how to purchase rental properties again, you would need to, for each locale:

* Determine best neighborhoods* Find a good property manager* Find a good crew to do rehab* (if applicable...hopefully not) Find a lender who would lend for your situation in that locale* Take trips out to inspect properties or buy sight unseen (which would require aforementioned good property manager)

That's a lot of fixed cost per new unit that you'd have to amortize.

You can still diversify within your real estate portfolio as long as you're in a reasonably sized MSA. You can:

We wound up sticking to the Fort Worth area because we had a property manager who was a rock star and we knew the rents and areas to buy. Because we have the great relationship with our property manager, we have access to the screaming steals since she knows that we'll pay cash and close within 7 days and give her the property to manage. I doubt that you'd build that type of relationship with multiple property managers in multiple areas. After all, how many people do you think property managers deal with who say that they're going to build up a portfolio and do a lot of business only for that promise to fall by the wayside? Better to actually deliver 2 or 3 properties to manage so that the property manager knows that you're legit.

You can make the numbers and the situation work anywhere if you're patient and disciplined enough.

I have clients who have properties in multiple locales, and, aside from one who visits the second locale many times a year because that's where the family goes for vacation, they all are happy to consolidate into one geographic region.

That is fantastic advice and insight, Jason. I owe you a beer the next time I'm in Dallas Ft. Worth (which we do visit from time to time). I especially love the advice that your clients eventually consolidate. I've been leaning that way, though the missus (i.e. - the boss) is leaning the other.

We do have two SFRs with one company, and they've been showing us additional good deals as a result. I love the relationship w/the turnkey company, especially as they took care of all the repairs found in the inspection at no additional charge. So I trust their work & approach.

"Would you simply load up in the city we're currently invested in, since we have a positive track record with the turnkey company and contractors we've already used? Would you just push forward with new regions and third parties?"

Finding good people (contractors/managment companies) is sooooooo hard. Finding them in another city sounds like a very difficult task. Also, I only like to invest in areas that I know extremely well. Trying to replicate your success in another city sounds like it would be much more hassle than it's worth. I like that you want to diversify, but I'd probably do it through other investment classes (index funds, peer lending).

I do like the idea of a multi unit that Even Steven mentioned. They seem to have greater cash flow.

Glad to see you back...I'm always looking forward to your posts. This is definitely a very timely topic for me as rental property has been on my mind and I've been reading about turnkey investing on biggerpockets. Being in NYC, real estate is expensive and would not cash flow. I've considered other locations, but have been struggling with analysis paralysis. I feel like there's more risk when you're buying out-of-state. I thought about upstate NY since my brother in law lives there, but the prop mgrs I've contacted don't seem to be too good about responding to my questions. I found a reputable turnkey company (from what I've heard I guess) and they operate in Memphis and Texas (Dallas/Houston) so I was considering that. Hope to hear more about this topic.

I think I know which company you're referring to. I've heard good things about them as well, but the numbers in Memphis and Texas don't seem appealing to me. The dealbreaker was when they told me about half their properties in Memphis don't appraise at value, leading to having to put down 30 to 40% of the purchase price. I couldn't move forward at that point...only because I don't want to ever buy a house for more than what an appraiser values it at. But I could also see how someone else could get comfortable with it, if cashflow was the #1 goal.

Thanks for the kind words, Andrew, too. It's nice to 'be back'. Let me know anytime you want to email or chat about this stuff.

Thanks! Good to know that. I definitely would have a problem with the property not appraising...it suggests that the price is too high. I'll have to raise that issue if I ever consider investing through that company.

Welcome back! I'm happy to be reading your posts again. I can't really help you on real estate though since my only attempt at it was a complete failure. I'm now scarred for life, and my only RE exposure is in REITs and our (future) home.

Thanks so much for that sweet comment, Three is Plenty. REITs have some real appeal for us, though I do wish there was a way to get the benefits of depreciation and some tax deductions through them. There are certainly days when I think just owning a primary residence (or maybe even renting) is the right way to go. :)

Congrats on your real estate investments, Mr. (and Mrs.!) DbF!! I'm glad the two have been cash-positive for both of you, very exciting! I don't know a lot about real estate investing, but I would be more conservative and sticking with areas around me (at least drive-able areas) so I could physically see if it I had to. A family member did this prior to her raising a family, and has it pretty dialed where she can look at a couple of properties once a month or so while the kids are now at school.

Hi Anna! I hear what you're saying about the tangible aspect of real estate. There is a part of me that wants to touch the bricks. Some day, I'm going to fly out to these houses we own, but have never seen, and touch the outside walls.

You guys have been busy! Our comfort level with real estate has never extended beyond areas that we know well and feel like we have an advantage of having a network or being "on the ground". I guess I view geographic diversification from a real estate perspective better performed through a REIT - as long as you're already paying middle-men for all sorts of other things you may as well get some ease and liquidity out of it. For that reason I'd really stick to one area for real estate investments, and preferably one we either have lived in, or planned to in the future. But I know that arebelspy on the MMM forums has lots of rental properties in several areas, so it's working for him!

Property investment is one of my goals. It will be interesting to read your progress. I understand the desire to spread the properties out to avoid risk, but as you and some of the other commenters have pointed out, that also increases your workload tremendously. Good luck!

Glad to see you posting again. I learn tons from your post. I wish I could offer insight, but we just bought our first home and are above the age of 40. However, people like Dave Ramsey are always going off about not being a long-distance landlord. I am not sure he is correct, but if you are looking for multi units there are tons in the Northeast that seem to be profitable. It is really common to see two family and three families, particularly in Boston and Providence where you have tons of students and could provide good income. Just my two cents, but just glad to see you back.

Thanks, Jason! I'm glad to have you here as a reader. We were ardent followers of Dave Ramsey for years. But we've come to get comfortable with some debt (e.g. - paying off credit cards in full every month, and using mortgages for rentals).

You have been busy! I like the point you made about your wife being comfortable with this area of investment - it's so important to be on the same page. I don't have any experience in this area at all I would always try to stay local purely because of the local knowledge aspect.

1. If it were me (and it never would be since our lawsuit with our most recent tenants is about to go trial), I would rather be an expert on one or two areas rather than try to research and keep tabs on multiple.

2. Certainly there have been many, many claims of folks getting quite wealthy by leveraging debt to invest in real estate. I have always witnessed the opposite - a domino effect debt fall-out with high stress and low margins. Of the investors I've personally known, only one has been calm and thrilled with their real estate (about 14 single family homes all in Salt Lake) - the one that paid for every unit with cash.

Their process was to set aside the rental income until they could buy the next one, which has snowballed into a new rental home investment about every 4 months at this point and no stress when they need to close up a home for a few months to renovate or can't find a good tenant for awhile. Plus, they are able to undercut all other local rentals, so they get the BEST tenants fighting over their units.

I'm so sorry that blogger ate your comment, Emily. I wish I were savvy enough, tech-wise, to figure out what causes that. And thank you for writing another comment, too.

One: I am very sorry you're having to go to trial with a tenant. That is a very sobering word of caution.

Also, we have thought about going the all-cash route. The problem is that, without leverage, I don't see returns that would justify actually investing in real estate. The cash-on-cash returns get into the low single digits: at that point, I'd rather just buy a boring old index fund. But, I might be looking at a very different market or type of investment property than your friend.

It's definitely giving me pause for thought. We could probably buy just one, all cash, right now, and it'd take a good long while to save up for the second. But after a while, the pace would accelerate as it did for your friend.

I had a somewhat similar problem, no mortgage, cash piling up, and less than 1% interest in an ISA. I never thought too much cash would be a problem ;) My solution was to upsize my home (that was a very difficult decision). I bought a fixer-upper with great potential in a nice location. No rental income of course (although I am going to be renting out a room to a friend), but it is tax efficient (no capital gains if I sell), and I sleep at night. I was tempted by a low cost index fund, but you can't live in one. My brother does rent out properties - his niche is expert local knowledge, and investment in purchasing properties only in highly sought after locations. The quality of tenants he's got is astonishing. Good luck with your plans, but I would definitely advise staying local with rental properties.

We just bought rental property nr 3, after buying nr 2 earlier this year, it seems like a great way to get some profit. We do buy locally though...the new house is at a small city only half an hour drive away. Its the first one we took a loan for. its still very cash positive though! In fact, loans are very cheap here in Europe for he moment, so its sometimes better to have a loan and keep,enough cash for if a next property comes your way. We always buy the cheapest property in a city center, that way, we are sure we can turn it for a profit, while there are plenty of people who want to be tenants.nina

Disclaimer: This blog is written for entertainment purposes only: not to give advice. I'm just some dude on the internet, and one without a whole lot of credentials. It's a good idea to consult with professional before making investment, tax, or financial decisions.